There has been so much news about negative gearing lately, yet you may not be aware of all that it implies. You may feel the need to change the channel of your TV every time the news associated with it comes up. Do not fret. We have Your Guide About Negative Gearing here! Negative gearing is something everyone can understand. In this article, you will find the relevant details you would need to comprehend the things surrounding negative gearing.
What is Negative Gearing?
In its simplest form, the term gearing is obtaining finance in order to facilitate the acquisition of an asset, such as a home loan for an investment property.. At first glance, negative gearing seems sufficiently basic; purchase the best property located in the best area and after that let the taxman and tenant support your reimbursements while you profit and benefit from the increase in value of the property. However, it goes beyond that.
When you purchase a significant investment, most people tend to borrow the money needed for the investment, which is the essence of gearing. However, the buyer now has to consider a range of expenses that include a mortgage, amongst rates and taxes, support costs, bank charges and others.
Negative gearing is basically the point at which the expenses of having the property (the total cost) are higher than the rent being paid by the occupants. In this way, the investment you just made is geared negatively as it is creating a loss of income.
On the other hand, positive gearing is the point at which the rent paid by the tenants exceed the expenses of having the property plus it provides you additional money. This generally occurs when your property has been practically paid off or the amount of rent received is considerably higher.
Why do some investors opt to create a loss from their investment?
The purpose behind this is that in the short term, the loss generated from having rental expenses exceed rental income allows you to claim this as a deduction in your tax return, which thereby results in lower tax payable or a higher refund. The long term outlook is that while the property currently produces losses, the value of the investment will increase. So if you decide to sell the property, the gain that you may make – which is calculated by deducting the purchase price, associated purchase costs and selling costs from the selling price – would be greater than the losses generated previously.
Negative gearing is simply an instrument that allows you to increase your wealth through the use of finance. However, you should bear in mind that the very premise behind negative gearing is that losses are to be expected in the short term, so that when you go to sell the asset the value would have increased to offset, if not exceed, the losses made.
This can be a very effective manner to reduce tax while simultaneously building your wealth, but we do highly recommend that you consult with your accountant so that you are aware of all the benefits and potential ramifications that are associated with negative gearing.